2007 latin american-business environment report

8/14/2019 2007 LATIN AMERICAN-Business Environment report

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Terry L. McCoyWith Meredith Fensom

September 2007

2007 LATIN AMERICAN BUSINESS ENVIRONMENT

REPORT


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September 2007

Preface

The Latin American Business Environment Report (LABER) is a one of a kindpublication that presents in a single document a straightforward, balanced appraisal of theeconomic, social, and political events in the past year that have shaped the business andinvestment climate in Latin America as a region and in its 18 most important economies.

In the 2007 LABER the ninth edition since 1999 (all available at

http://www.latam.ufl.edu/labe/publications.html) we have consolidated coverage ofCentral America and the Caribbean (dropping Jamaica and Trinidad & Tobago) into the

new DR-CAFTA region, which coincides with the recently launched bilateral free tradeagreement between the United States, five Central American countries and theDominican Republic. Although Costa Rica has yet to ratify the agreement and Panama isnot a member, both are analyzed as part of this new consolidated section. We have alsoenhanced assessment of the legal environment, which is again the work of MeredithFensom.

TheLABER is a publication of the Latin American Business Environment Program in theCenter for Latin American Studies. The program draws on the expertise and resources ofthe University of Florida to prepare students for careers related to Latin Americanbusiness through degree programs, training courses and study abroad opportunities. It

also organizes topical conferences, promotes the publication of scholarly research andprovides professional consulting services for the business community and public.

Additional support for theLABER and related activities is generously provided by theCenter for International Business Education and Research (CIBER) in the WarringtonCollege of Business Administration. Mary Mitchell and Alison Boelter helped preparethe 2007 report, which was edited by Charles Wood. Finally, in preparing the 2007report, I benefited from an evaluation of the previous LABERs conducted by AmbassadorMyles R. R. Frechette. I alone am responsible for the content and analysis.

Terry L. McCoy, DirectorLatin American Business Environment [email protected]/labep.html

The report may be cited without permission. Users are asked to acknowledge the source.


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CONTENTS

Preface

EXECUTIVE SUMMARY...4

INTRODUCTION...5

I. REGIONAL OVERVIEW......8

EXTERNAL ENVIRONMENT.......8

Global Developments

Regional Developments

DOMESTIC ENVIRONMENT..10

Economic and Financial Performance

Social Environment

Political Environment

Policy Environment

Legal Environment

II. COUNTRY PROFILES....................19

NAFTA REGION............19

Mexico

DR-CAFTA COUNTRIES.........21

Dominican Republic

Costa RicaEl Salvador

Guatemala

Honduras

NicaraguaPanama

ANDEAN SOUTH AMERICA..........28

Bolivia

Colombia

Ecuador


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Peru

Venezuela

BRAZIL AND THE SOUTHERN CONE.....34

BrazilArgentina

Chile

ParaguayUruguay

III. OUTLOOK....41

OUTLOOK FOR THE REGION...41

External EnvironmentDomestic Environment

COUNTRY OUTLOOKS...43

Attractive Environments

Problematic Environments

Mixed Environments

TABLES49

SELECTED SOURCES..64


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2007 LATIN AMERICAN BUSINESS ENVIRONMENT REPORT

INTRODUCTION

The environment for business in Latin America continues to be attractive. The

region has prospered from four years of export-led growth, accompanied by low inflation

and healthy capital flows. In the policy arena most governments continue to pursue

macroeconomic stability through policies that implement inflation targeting, fiscal

discipline, and floating exchange rates. There are, however, significant differences

among the countries of the region. Particularly noteworthy are the populist regimes

exemplified by President Hugo Chvez in Venezuela that are re-imposing state

intervention in the economy and reducing the role of foreign capital. As we enter the last

quarter of 2007, there is also growing concern with the volatility gripping global financial

markets and the prospects of an economic slowdown in the United States.

Figure 1

Model of Latin American Business Environment

External Environment

Economic

-------------

Financial

Social

Political

Policy

---------------

Legal

Global

Regional

Domestic Environment


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Whether Latin America or the individual economies of the region grow or enter

into a recessionary cycle is the result of a complex interplay of factors that operate at the

internal and external levels. This analysis uses the conceptual framework shown in

Figure 1 to capture the most salient components of the Latin American business

environment. Last year we added a legal component to the framework in recognition of

an increasingly important dimension of the business environment the rule of law. New

this year in our assessment of the legal environment is the degree to which private

property rights are protected (Table 13) and the magnitude of bureaucratic burdens

imposed by the state on businesses, and estimated trade losses due to copyright piracy

(see Table 14).

Part I of the 2007 LABER summarizes major regional developments that took

place in the last quarter of 2006 and through the first three quarters of 2007. Part II

presents thumbnail sketches of the 18 largest markets, grouped by geographic region

and/or trading blocs (see Map and Table 1). This edition no longer has separate section

for the Caribbean and Central America. Instead we have dropped coverage of Jamaica

and Trinidad & Tobago, and folded the Dominican Republic into the new DR-CAFTA

region. Part III re-arranges the countries according to an assessment of their business

environments overall and according to the outlook for the next 15 months. The 14

appended tables contain country-level data, along with regional averages of key

economic, social, political and legal variables. At the end we include a list of selected

sources that provide business-related news on Latin America, which informed the 2007

LABER.


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MERCOSUR

NAFTA

ANDEAN

COMMUNITY

DR-

CAFTA

Venezuela

Colombia

Brazil

Ecuador

Peru

Bolivia

Argentina

Chile

Uruguay

Paraguay

Panama

Costa Rica

Mexico

El SalvadorGuatemala

Nicaragua

Honduras

Dominican

Republic


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I. REGIONAL OVERVIEW

EXTERNAL ENVIRONMENT

The external environment has been quite favorable for Latin America in recent

years. The booming world economy produced high commodity prices and favorable

terms of trade for the region. While the United States continues to be Latin Americas

most important market, the region is increasingly linked to China, India and other

emerging economies. Latin America also benefited from the expansion of global capital

flows, both on the equity and debt side. The financial market volatility that broke out in

the second half of 2007 makes the external environment more uncertain.

Global Developments1 Stronger terms of trade for commodity exporters

With a big jump in 2006, the barter value of what Latin America sells on worldmarkets relative to the cost of what it imports from abroad improved for the fifthyear in a row, and regional terms of trade continue to be favorable in 2007 (Figure2). However, they were not uniform across the region (Table 2). The big gainsagain accrued to the five economies of Andean South America and Chile and, to alesser extent, Argentina, Brazil and Mexico. The terms of trade for all seven DR-

CAFTA economies net energy importers and increasingly dependent onmanufactured exports actually declined. While the robust expansion of theChinese and Indian economies is sustaining high commodity prices, LatinAmerican manufacturers find it hard to compete against Chinese exports

Increasing volatility emerged as potential threat to favorable capital marketsDuring much of 2007 Latin America continued to attract greater capital flows andpay lower interest rates. Although the region has attracted a diminishing share offoreign direct and portfolio investment than the other emerging markets, the flowhas been important to current growth. FDI to the region will be greater in 2007than in 2006 (Figure 3). Increased global liquidity has also made it easier to

finance debt, both sovereign and corporate. Overseas remittances are significantsources of hard currency for all countries in the region. While the financialmarket volatility of July-August 2007, triggered by the U.S. sub-prime lendingcrisis, raised country spreads, it has not yet provoked major problems for LatinAmericas increasingly securitized financial markets. Increasing access to privatecapital has meant less reliance on the International Monetary Fund.

1 Symbols are used here to suggest overall trends over the past 12 months: improving; declining; = nosignificant change.


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Figure 2

Figure 3

Terms of Trade for Latin America, 1997-2006(Source: ECLAC 2006)

95.0

91.3

94.5

100.0

96.3 96.6

98.6

103.9

109.0

117.5

80.0

90.0

100.0

110.0

120.0

130.0

1997 1998 1999 2000 2001 2002 2003 2004 2005 2006

2000=100

Net Foreign Direct Investment in Latin America, 1997-2006(Source: ECLAC 2006)

57,599

60,999

79,923

70,308

63,659

45,213

35,114

43,149

49,206

33,483

0

10,000

20,000

30,000

40,000

50,000

60,000

70,000

80,000

90,000

1997 1998 1999 2000 2001 2002 2003 2004 2005 2006

MillionsofUSDollars


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World trade negotiations stalledDespite periodic assurances from major players in the World Trade Organization,commitments to resume the Doha round have not materialized. With PresidentBush losing trade promotion (fast track) authority in July, and the Democratically-controlled Congress unlikely to easily renew it, the future of trade talks under

WTO auspices grows even more problematic. A mid-August WHO decision toextend the deadline for developing countries to cease subsidizing manufacturingexports with tax breaks until 2015 was welcome news for those Latin Americancountries with export processing zones.

Regional Developments =

Path of hemispheric trade liberalization uncertainWith the Free Trade Area of the Americas (FTAA) dead and WTO negotiationsgoing nowhere, trade strategies shifted to forging smaller, sub-regionalagreements. Over the past four years, the United States has negotiated free trade

agreements (FTAs) with Central America and the Dominican Republic (DR-CAFTA), Peru, Colombia and Panama (Table 1). Led by Brazil and Venezuela,the South American countries set out to merge MERCOSUR and the AndeanCommunity into a counterpart of NAFTA, or SAFTA. Both initiatives are now indoubt. Congress is dragging its heals on bringing the three unratified FTAs up fora vote even after the administration and signatory nations agreed to incorporateprovisions affecting labor and the environment insisted on by the Democrats. Onthe South American front, Venezuela is threatening to withdrawal fromMERCOSUR. President Chvez continues to push his Bolivarian Alternative forthe Americas (ALBA) of which Cuba Bolivia, Ecuador and Venezuela aremembers.

Immigration unresolved issue in U.S.-Latin American relationsPresident Bushs March goodwill visit to five Latin American countries whenhe addressed issues of concern such as poverty and inequality was a gesturetoward rebuilding U.S.-Latin American relations. However, Congress rejectionof President Bushs comprehensive immigration reform later in the year was aserious setback. There is some evidence that tighter control of the U.S.-Mexicanborder reduced the flow of undocumented immigrants and their remittances.

DOMESTIC ENVIRONMENT

The domestic components of the business environment are generally positive: all

Latin American economies are growing; inflation is under control in most, and local

currencies are strong. Domestic capital markets are stronger, while the external debt

burden is declining, along with unemployment and poverty. The political and legal


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components of the business environment are mixed. Even though the most recent round

of elections did not result in the leftist take-over some observers predicted, it did bring

several left-leaning populist governments to power. This means that investors should

keep informed of events in individual countries and the growing differences in their

policy agendas. Trade agreements have become the primary determinants of legal

reform.

Economic and Financial Performance The Latin American economies performed well over the past year, and the

outlook is promising into 2008. The sustained expansion has helped the region regain the

losses in per capita income suffered from 1998 to 2003.

Strong economic growthFor the second time in the current cycle, regional growth exceeded 5.0% (Figure4) in 2006 with all countries except one (Brazil) surpassing 3.5% (Table 4).Regional GDP is on track to exceed 5.0% in 2007. The rolling ten-year averagefor annual growth is 3.0% up from 2.3% in 2004. Although exports continue tobe the major determinant of GDP growth, government spending, investment andconsumption are important components as well.

Inflationary pressures buildingInflation dropped again in 2006 at the regional level, but inflationary pressures arebuilding in 2007 (Figure 5). Demand and supply factors threaten to push inflationbeyond targets set for the year. In response, the central banks in several countries(Chile, Colombia, Mexico and Peru) have begun to increase interest rates, or slowmonetary expansion (Brazil). Venezuela and Argentina imposed price controls tocope with the highest inflation in the region (Table 5).

Deepening domestic capital marketsThanks to demand from international investors, local pension funds, asset

managers, and insurance companies, Latin American stocks closed out 2006 withthe fourth straight year of impressive gains. The Argentine, Brazilian, Chileanand Mexican indices were up 35%, 33%, 37% and 49% respectively. Colombianand Peruvian equities also did well. After a strong start in 2007, Latin Americanmarkets suffered two corrections. In August they were off 8-9% from their peaks.With lower global interest rates and narrower country spreads, the cost of debtfinancing has also been favorable, and local currency bonds are becomingcommon.


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Strong external performanceWhile FDI is up only slightly, exports experienced a significant increase (up 20%annually), as did the current account surplus (see Figures 3 and 6). Total foreigndebt fell to its lowest level since 1997, and the debt burden, measured by the

debt/export ratio, became less onerous (Figure 7). Finally, Latin Americancurrencies held their own or appreciated against the dollar, and only six countries(vs. nine in 2005) are currently under IMF agreements (Table 9). In the middle of2007, at the onset of financial market volatility, Latin American country riskspreads increased (Argentinas rose to 490 basis points from 240; Venezuelas to509 from 231; Brazils to 216 from 139 and Colombias to 200 from 119),although they remained comparatively low.

Figure 4

Regional GDP Growth Rates for Latin America, 1997-2007

(Source: ECLAC 2006 and IMF Economic Outlook 2007)

5.5

2.6

0.4

3.9

0.3

-0.8

2.0

5.9

4.5

5.3

4.9

-2.0

-1.0

0.0

1.0

2.0

3.0

4.0

5.0

6.0

7.0

1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007

PercentageCha

nge


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Figure 5

Figure 6

Average Annual Inflation Rate for Latin America, 1997-2007(Sources: ECLAC 2006 and IMF Economic Outlook 2007)

10.7

10.09.7

9.0

6.1

12.2

8.5

7.4

6.1

4.85.2

0.0

2.0

4.0

6.0

8.0

10.0

12.0

14.0

1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007

PercentageChangeinCPI

Exports and Imports of Goods and Services in Latin America, 2003-2006(Source: ECLAC 2006)

378,206

466,311

560,629

677,170

333,513

405,998

479,391

573,524

50,000

150,000

250,000

350,000

450,000

550,000

650,000

750,000

2003 2004 2005 2006

MillionsofUSDollars

Exports

Imports


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Figure 7

Social Environment The current economic expansion has reduced poverty and unemployment and

improved income growth and distribution (Table 10). Crime remains a persistent

problem throughout the region. Criminal activity has become increasingly violent in

recent decades, although some countries (most notably Colombia) are making strides in

improving citizen security (see Table 13).

Growth in per capita income acceleratingSince the recovery began in 2003, the rate of per capita GDP growth has averaged

around 4.0% compared to negative growth in the previous five years. Real wagesnow surpass where they were at the beginning of the decade.

Poverty continues to declineBetween 2002 and 2005, the proportion of the population living in povertydropped below 40% (from 44%), and the proportion indigent fell to 15.4% from19.4%, according to ECLAC. With targeted income transfer programs and thesustained economic growth of 2006-07, poverty continues to decline.

Gross Disbursed External Debt, 1997-2006(Source: ECLAC 2006)

680.3

742.7762.3

738.2 744.6 733.1757.8 761.3

656.1632.8

83101

138168

178181172

211216198

0.0

100.0

200.0

300.0

400.0

500.0

600.0

700.0

800.0

900.0

1997 1998 1999 2000 2001 2002 2003 2004 2005 2006

PercentageChange

Debt (Bi ll ions of US Dollars) Debt as % of Exports of Goods and Services


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Unemployment fallingThe regional average for open urban unemployment has dropped from 11.0% in2003 to 8.9% in 2006 largely due to the effects of strong employment creation inthe formal sector, which offers higher paying jobs with benefits.

Crime and threats to personal security largely unabated

Latin American governments must engage in a costly multi-front war to reducecrime. Drug-trafficking is now a threat throughout the region. In CentralAmerica, the traffickers work with the gangs; in Colombia with the leftwingguerrillas and rightwing paramilitaries. Kidnapping is a criminal enterprise insome countries, and run-of-the-mill street crime is rampant in most, as thereported incidence of victimization in Table 13 documents.

Political Environment =

The large number of elections (11) over the past two years did not result in the

dramatic swing to the left some had predicted. Voters in Bolivia, Ecuador and Nicaragua

nonetheless elected leftist-populist governments patterned after and loosely allied with

Hugo Chvez, who was also returned to office in Venezuela (Table 11). In addition,

leftist challengers narrowly lost in Mexico and put up a good fight in Peru. It is

important to note two additional trends in assessing recent elections: first, transfers of

power take place in Latin America through regularly scheduled elections and, second,

other presidents with leftist roots (in Brazil, Chile, Uruguay, Peru and Costa Rica) have

chosen not to align with Chavez but to pursue a more moderate, pragmatic path.

Limited political re-alignmentLatin Americas political landscape has changed. The Venezuelan-led neo-populist alternative complicates domestic politics, policy choices and relationswith the U.S.

Constituent assemblies seek to consolidate political changeEven though electoral democracy remains in place, representative democracy isclearly at risk in Venezuela. Bolivia and Ecuador are both following theVenezuelan example of convening constituent assemblies to rewrite theirconstitutions and transform their political systems. President Chavez, skillfullymobilizing his popularity and the widespread desire for change amongVenezuelans, has used assemblies and national referenda to concentrate power inthe presidency and weaken the opposition and other branches of government.


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Figure 8

Legal Environment =

The efficient conduct of business requires a legal environment in which rule of

law is institutionalized. Production, commerce, and trade require a transparent and

effective legal system that ensures the enforceability of contracts and reduces the cost of

doing business. While no country is perfect in this regard and Latin America as a

region is comparable to other emerging markets the troubling fact remains that the legal

environment in most countries fails to fulfill the needs of domestic and international

capital, which is why legal reform is a high priority. Those countries in which the rule of

law is institutionalized (see Tables 13 and 14) Chile, Costa Rica and Uruguay have

the most attractive business environments.

Fiscal Deficit/Surplus as a Percentage of GDP, 1997-2006(Source: ECLAC 2006)

-1.2

-2.3

-3.1

-2.7

-3.3-3.2

-2.9

-1.9

-1.2

-0.3

-3.5

-3.0

-2.5

-2.0

-1.5

-1.0

-0.5

0.0

1997 1998 1999 2000 2001 2002 2003 2004 2005 2006

PercentageChange


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Bilateral trade and investment agreements impose legal reformDR-CAFTA member countries incorporated judicial reforms to comply with theagreements legal obligations. A compromise agreement reached in the U.S.Congress to renegotiate free trade pacts with Panama, Peru and Colombiaincluded binding commitments for the three countries and the U.S. to abide by

core International Labor standards and requirements that trading partners enforceexisting environmental laws and comply with several international environmentalagreements. Intellectual property rules are altered by the deal, with the aim ofallowing developing countries quicker access to generic drugs. Future trade dealswill require signatories to adopt, maintain and enforce the five fundamentalstandards of the International Labor Organization and will allow the use of tradesanctions to punish offending countries.

.


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II. COUNTRY PROFILES

NAFTA REGION

Immigration and drugs continue to test U.S.-Mexican relations, and further North

American regional integration under the NAFTA umbrella is at a standstill. U.S.

immigration policy is a major irritant in bilateral relations, brought to the fore again this

year when Congress rejected the administrations immigration reform package. As the

threat posed by drug traffickers in Mexico became even more alarming in the past year,

the U.S. government helped finance a major drug fighting initiative by the Caldern

government.

Two years ago, the three NAFTA countries endorsed the Security and Prosperity

Partnership as a step toward deepening North American integration. But at their meeting

in Canada in August, it became obvious that the three North American leaders were

presently in no position to expand NAFTA. Instead they adopted several non-

controversial technical measures. Regional integration suffered another setback in

September when the U.S. Congress voted to exclude Mexican trucks from hauling freight

into the United States (and on to Canada) shortly after a U.S. court ruled that they could

do so in keeping with provisions of NAFTA.

Mexico2: New president consolidates power and advances his policy agenda. More dynamic economy

GDP growth in 2006 was the highest since 2000, although the rate is expected to

fall off in 2008, while inflation remains under control.

Financial markets mixedThe banking sector continues to make strides. More accessible credit triggered aboom in mortgage financing and housing construction. The stock market index is

2 The symbols for each country indicate the following trends: business environment improved,business environment deteriorated, = no significant change since 2004 report.


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up over 400% in the past four years, but the market has been losing listings. Eightcompanies de-listed in 2007, and there are no IPOs thus far. The large groups thatdominate the economy do their financing through private arrangements. A $37bninfrastructure construction initiative to be jointly funded by public and privateinvestment could revive equity investments.

Favorable terms of trade support strong external positionFDI experienced a healthy increase in 2006. Exports also increased, while thecurrent account deficit declined. Total external debt was up slightly, but thedebt/export ratio, the lowest in Latin America, declined. Both Fitch and S&Pupgraded Mexicos credit ratings in March to positive from stable inrecognition of Mexicos strong external position and prospects for fiscal reform.

Government launches major anti-drug initiativeViolence perpetuated by drug gangs worsened during the year.

Political system rebounds from contested election

After taking office in a razor thin, contested election and without a PANmajority in Congress Felipe Caldern proved to be a strong, effective presidentin his first year, which he finished with a 50% favorable public approval rating.He succeeded in pushing the promised PRD parallel government into thebackground. A more disturbing challenge came from a shadowy leftist group(ERP) that engaged in a series of bombings of PEMEX pipelines during thesummer.

Movement on policy reformsCaldern did more to advance reform in one year than his predecessor in six.

Working with the opposition PRI, he pushed bills to reform the governmentpension plan and tax systems through Congress. The former reduces drain on thetreasury. The latter will close loopholes in the corporate-tax code generatingincreased fiscal revenue to finance investments in infrastructure and educationand lessening dependence on PEMEX as a source of government funding. To getthe tax reform, the President had to support a controversial electoral reform thatmay strengthen the role of political parties in elections. Following passage of thetax reform, Fitch again upgraded its ratings arguing that it offered hope thegovernment would work with Congress to pass future reforms.

Decisions boosting competition

Mexicos Supreme Court struck down a provision in a law that would haveallowed Mexicos two television companies free use of the radio spectrum to offertelephone and internet services. Congress passed a bill that could give the centralbank a role in setting the fees and interest rates charged by banks in order to boostcompetition in areas where Mexicos anti-monopoly commission finds thatcompetition is lacking. A pension reform proposal to rise the retirement age andphase in individual savings accounts was blocked.


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DR-CAFTA COUNTRIES

DR-CAFTA modified the rules for U.S. trade and investment with Central

America and the Dominican Republic. Although only in operation for a short time, the

agreement seems to be generating greater U.S.-Central American trade (the Dominican

Republic did not become a full member until March). Export growth may, in turn, be

translating into higher overall growth for the Central American members. However,

Costa Rica, yet to ratify the agreement, also experienced trade expansion, healthy GDP

growth, and strong FDI flows. The United States may be the big winner at least in the

short-run because the agreement grants 80% of U.S. exports immediate duty-free access

to DR-CAFTA markets. U.S. exports to the region increased by 16% in 2006, and were

up by another 11% in the first five months of 2007. It now runs a trade surplus with the

DR-CAFTA countries.

Costa Ricas October referendum on DR-CAFTA membership has implication

not only for Costa Rica but also for the future of Central American integration. The

European Union suspended negotiations for a trade pact with Central America until the

outcome of the vote is known. Should it be negative, the EU may break off talks since it

insists on negotiating with the region as a bloc, not only on trade matters but also on

standards in customs and tax systems. All of the Central American countries except

Costa Rica adopted a Central American visa that allows their citizens to freely cross

borders. Excepting Costa Rica, almost 95% of trade within Central American trade is

now duty free.

On the energy front, the region is making progress on creating a regional power

grid (Siepac, Central American Electric Interconnection System). Furthermore, Brazil


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and the United States have joined forces to promote sugar-cane ethanol production using

Brazil-developed technology in Central America, which can then take advantage of DR-

CAFTA to be exported duty free to the United States.

Dominican Republic: Full DR-CAFTA membership strengthens environment. High growth continues

GDP growth topped 10% in 2006 and is predicted to reach 6.0% this year.Although still moderate, inflationary pressures are of some concern.

Mixed external positionExports were up in 2006 but so was the current account deficit. Because DR-CAFTA further liberalizes access to the Dominican market for the four CentralAmerican members as well as the United States, there is concern that the deficits

the Dominican Republic has been running with both Central America and theUnited States could worsen. FDI has recovered from the downturn associatedwith 2002-03 economic crisis, and may receive a bump this year from DR-CAFTA. The country continues to operate under the conditionality of an IMFstand-by agreement. In May, Moodys upgraded the Dominican Republic to twonotches below investment grade, while Standard & Poors raised its long-termcredit rating in September based on implementation of structural reforms andimproved fiscal accounts.

Poverty declining but still highThe high rate of growth of the past 15 years has not improved the standard of

living of most Dominicans. Failure to perceive meaningful trickle down is anongoing source of social tension.

Politics shifting to election modeIn spite of his fall in public opinion polls, Leonel Fernandez appears headed for athird term in the May 2008 presidential contest since the opposition is unlikely tomount a serious challenge.

Items on policy agendaUnder pressure from the IMF, the Dominican Congress finally enacted criminalpenalties for illegal use of electricity as a step toward ending the power shortage

and chronic blackouts. The fiscal deficit has been brought back under control.

DR-CAFTA reforms strengthen legal environmentTo comply with terms of DR-CAFTA and under pressure from Washington, theDominican Congress approved reforms affecting protection of intellectualproperty rights, customs procedures and other matters that will improve businessregulation if enforced. Foreign investment opportunities have been undermined


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by the absence of standardized competition laws and the failure of the governmentand private parties to honor contracts.

Costa Rica=: Membership in DR-CAFTA goes to popular vote.

High growth and declining inflationFor the third year in a row, GDP growth will be at or near 6.0%, giving CostaRica the second highest (5.1%) rolling ten year average of the 18 countries (Table4). Inflation, down in 2006, is expected to decline again this year. In October2006, the central bank moved to let the colon float within a narrow band.

Strong external performance without DR-CAFTAAlthough terms of trade are weak, exports increased (along with imports and thecurrent account deficit) as did FDI while both the external debt and debt/exportratio (second lowest of the 18 countries) declined. The WTO ruling that extendedthe deadline for ending duty free industry export subsidies is important to CostaRica where this sector has experienced rapid expansion in recent years. CostaRica became the first Central American nation to break relations with Taiwan andre-establish relations with China. The move recognized Chinas growingimportance as a trading partner and source of foreign investment.

Labor shortagesThe demand for migrant workers, mainly from Nicaragua, in the agricultural andbooming construction sectors (with local workers taking higher paying jobs inmanufacturing and services) runs up against anti-immigrant sentiments and recentlegislation making it more difficult to hire foreigners.

Referendum test for administration.In keeping with their strong democratic tradition, Costa Ricans will go to the pollson October 7 to decide whether they will join DR-CAFTA. The NationalAssembly has been deadlocked over the issue. President Arias is an outspokenproponent of the agreement.

Market-opening legal reforms pendingCosta Rica has one of the strongest legal environments in Latin America.The new cdigo contencioso and ley de certificados could affect foreign investors

and local businesses. The cdigo broadens the role of judges in civil cases and isaimed to achieve greater equality between litigating parties. La ley regulates theuse of and gives legal recognition to digital signatures and certifications ofdocuments transmitted via the Internet. There is a draft bill in the congress tosimplify claims for small sums of money, similar to the small claims courts in theU.S. A series of laws are also under discussion aimed to increase competition inthe telecommunications sector and streamline the bidding process for private


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companies seeking government contracts. Compliance with DR-CAFTA wouldmandate other reforms.

El Salvador: Signs of boost from DR-CAFTA membership. Encouraging economic performance

Economy is on track in 2007 to equal or exceed 2006 growth, which was thehighest in 10 years. Dollarization keeps inflation under control.

Remittance growth slowingOverseas remittances, which account for 18% of GDP and are crucial to closingthe current account deficit, are slowing. Extension of U.S. Temporary ProtectionStatus for 230,000 Salvadoran immigrants guarantees that their remittances willnot be cut off in the near future.

Emigration slowing population growthThe most recent census shows that total population size is nearly 20% beloworiginal projections, presumably because of emigration (estimated to be 80,000per year). This means that average per capita income is higher than initiallycalculated but so is the homicide rate, which is among the highest in the worldlargely due to gang violence.

Compliance with DR-CAFTA strengthened legal environment

Guatemala=: Violence mars national elections.

Encouraging economic performanceOver the past three years growth has been at its highest level since the mid-1990s,while inflation remains under control.

Mixed external performanceFDI increased by over 50% in 2006, in part due to DR-CAFTA going into effect.Export growth was modest, and the country is running a large current accountdeficit, which it finances through external borrowing. The foreign debt grew in2006, but the debt/export ratio declined. In July, S&P raised the outlook forGuatemalas long-term credit ratings.

Violence, endemic poverty and inequality weaken social environmentFueled by drug traffickers seeking to control transshipments through CentralAmerica, Guatemala has one of the highest homicide rates in the world (morethan 5,000 murders a year). During the election campaign more than 50politicians and activists were killed. In March three Salvadoran congressmenwere murdered, allegedly by police officers. Although the percent of thepopulation living in poverty has declined, it is still very high. Guatemala has the


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highest rate of child malnutrition in the Western Hemisphere, according toMillennium Development Goals report.

Presidential election goes to run-offIn keeping with the electoral pattern since returning to democracy in 1985, voters

rejected the candidate of the governing party but were unable to deliver a majorityto either of the top opposition candidates, which means a November run-offbetween three-time candidate of the center-left UNE, Alvaro Colom, and formergeneral Otto Prez Molina of the conservative PP.

Prudent macro-economic policyThe fiscal deficit fell from over -2.3% in 2003 to -1.5% last year.

Marginal strengthening of legal environmentNew legislation aims to improve tax collection to reduce tax evasion and taxfraud. Guatemala has also undertaken CAFTA-DR related reforms to intellectual

property, trade secret, and tax laws. Despite these reforms, it has one of the mostproblematic legal environments in Latin America in terms of rule of law andcorruption.

Honduras= : Some strengthening of weak environment

Sustained growthGDP growth has averaged over 4.0% a year since 2000. Construction is the mostimportant source of growth. Inflation is inching down, although it is still high incomparative terms.

Remittances crucial external componentWith remittances accounting for around 25% of GDP, the decision of the U.S.government to grant an 18-month extension of Temporary Protected Statusprovision for Hondurans means that the rate of deportation will stabilize andremittance remain steady for the time being. After Nicaragua, Honduras has theweakest terms of trade of the 18 countries. FDI and exports are holding steady.The current account deficit has declined. The IMF Poverty and GrowthReduction Facility will end this year unless renewed.

Criminal violence and poverty mark social environment

U.S. policy to send criminals back to their country of origin has increased gangactivity in Honduras. Nearly 75% of the population still lives below the povertyline, and Honduras is the poorest country in Central America in terms ofpurchasing power parity per capita income

Stable political environment


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Effective fiscal policyThe deficit fell to -1.0% in 2006 from -5.3% in 2001. The government announcedthat it was going to float a global bonds issue to help clean up finances of the statepower company, but the sale has been postponed.

Measures to facilitate business transactions

Efforts on behalf of the Comit Nacional de Simplificacin Administrativareduced from 62 to 44 days in the number of days required to start a business.

Nicaragua=: New government flirts with populism.

Satisfactory economic performanceSince 2003 growth has averaged over 4.0%, below the regional average but goodby Nicaraguan standards. Inflation is not a threat.

Contradictory external orientationNicaragua is a poor country with the weakest terms of trade and highest debtburden in Latin America. FDI flows have been modest but crucial (as areremittances and international aid). After assuring foreign investors they hadnothing to fear, the new Sandinista government has pursued an erratic pathcontributing to an uncertain investment climate. While embracing membership inDR-CAFTA, it has strengthened relations with Venezuela which has beengenerous in its aid and joined the Bolivarian Alternative for the Americas(ALBA). The new government has challenged the United States on other fronts,including establishing diplomatic relations with Iran and strengthening relationswith Cuba. It is currently involved in a dispute with Esso Standard Oil Company

regarding its refusal to refine Venezuelan oil. Washington has adopted a wait-and-see posture to this point. The government has negotiated a new loanagreement with the IMF.

Challenging social environmentHurricane Felix inflicted significant damage.

Opposition challenges OrtegaFormer president Daniel Ortega formed a coalition with one-time enemies to takeadvantage of changes in the electoral laws to return to office with only 38% of thevote in the November 2006 election. Many charge that the alliance (el pacto) will

exchange favors (former president Alemn convicted of misappropriating $100million had his sentence eased, for example, by the Ortega government) toinstitutionalize their power-sharing control of government. However, inSeptember the three opposition parties united in the National Assembly to weakenOrtegas controversial initiative to form citizen councils as a step toward directdemocracy.


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Mixed policy agendaThe fiscal deficit has come down in recent years, and the Ortega administrationhas reduced government salaries in order to increase spending on health andeducation. Unresolved is the role the state will play in the economy.

Uncertain legal environment

To become eligible for CAFTA-DR, Nicaragua reformed its banking and financelaws and strengthened intellectual property protection and customs enforcement.On the other hand, the government ambivalence on private property rights andother measures undermines investor confidence.

Panama: Canal expansion opens new era Another strong economic performance

Since 2004 the service-based economy has grown at around 7% annually thanks

largely to rapid expansion of the transportation/communications sector whileinflation of the dollarized economy remains low.

Awaiting ratification of U.S. FTAFDI doubled in 2006 (and was up 20% in the first half of 2007) to the highestlevel in Central America. Exports were up while the current account deficitcontinued to decline. External debt increased but the debt/export ratio declined.The United States and Panama concluded negotiation of a bilateral FTA, whichthe Panamanian legislature ratified. The U.S. Congress has yet to vote on themeasure.

Voters give Torrijos victory on the canalIn the October 2006 referendum, 78% supported the presidents call forexpansion.

Canal expansionto test fiscal policyConstruction on two new sets of locks began in September. It is expected to cost$5.2 billion and be finished in 2014-15. To finance the expansion, thegovernment is borrowing up to $2.3 billion, which will increase its external debtand put a strain on the budget during the construction phase.

Legal environment awaits FTA

Ley 22, passed in 2006, aims to help smaller businesses gain access togovernment contracts. The website www.panamacompra.gob.pa, was createdunder the same law to make the government procurement process moretransparent during construction of the canal. Corruption remains a concern, withforeign firms claiming they are hampered by the informal links betweengovernment and local business groups. Ratification of FTA would necessitateadditional legal reforms.


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ANDEAN SOUTH AMERICA

Although the Andean Republics of South America continue to benefit from high

commodity prices and favorable terms of trade, the state of sub-regional relations and

integration is unsettled on several fronts. The first uncertainty concerns where

Venezuelas loyalties lie. Is President Chvez casting his lot with MERCOSUR, with the

Andean Community (CAN), or with his own Bolivarian Alternative for the America

(ALBA)? Bolivia is following Chvezs lead, but Ecuadors new president, Rafael

Correa, who seems to be aligning Ecuador with the Chvez-led populist bloc, has

expressed reservations about membership in ALBA. The second question concerns

Chiles role in the Andean region. With great fanfare, Chile rejoined CAN in June,

which it had abandoned in 1976. But Chile did so only as an associate member, since it

refuses to abide by the Communitys common external tariff. More troubling are Chiles

ongoing territorial disputes with Bolivia and the maritime boundary disagreement with

Peru that erupted in August. Following Chiles return to CAN, the EU renewed

negotiations with CAN to forge a bloc-to-bloc free trade agreement.

The third uncertainty in the Andean region concerns the fate of the U.S. bilateral

FTAs with Peru and Colombia. Will Congress allow them to go into effect? If they do

go forward, what will be their impact on regional trade patterns and on prospects for the

Andean Community and MERCOSUR merging into a SAFTA? Washington has

temporarily extended the Andean Trade Preference and Drug Eradication Act

(ATPDEA), which gives Colombia, Ecuador, Peru and Bolivia preferential access to the

U.S. market. The two pending FTAs would make this arrangement permanent for Peru

and Colombia, and would liberalize U.S. access to their markets.


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Bolivia=: Progress but Constituent Assembly adds uncertainty in problematicenvironment

Strong growth and moderate inflationGDP growth is averaging over 4.0% per year, a significant achievement given the

unsettled nature of the environment. Inflationary pressures are building.

Mixed external positionBolivia has parlayed favorable terms of trade into strong export growth and ahealthy current account surplus. The increasing share of export earnings capturedby the government has produced a fiscal surplus as well. Bolivias external debtand debt burden are down, although still quite high. FDI has been weak, but withthe foreign oil companies accepting renegotiated contracts, it should pick up. InJuly Jindal Power and Steel Ltd of India made the largest foreign investmentcommitment in Bolivias history at $2.1bn.

Polarized social environmentThe main cleavage in Bolivian society, which spills over into politics, is betweenthe indigenous highlands and eastern lowlands dominated by affluentconservative elite.

Constituent Assembly dominates politicsPresident Morales, who is completing his second year in office, has proved to bemore effective than anticipated. However his commitment to deliver a newconstitution to voters was in doubt in September as the Constituent Assemblysuspended its deliberations for a month following clashes over relocating thecapital from La Paz to Sucre.

State intervention in economy deepeningA December law that authorized new contracts to increase government controlover the operations of foreign companies and the governments share of theirrevenues completed nationalization of the petroleum industry. Most companiesagreed to renegotiate, calculating that, in an era of high energy prices, they canstill make a profit on their Bolivian operations. The President subsequentlyannounced the nationalization of the mining sector and called for governmenttake-over of the countrys railroads. He signed into law a measure to redistributeunproductive private land.

Legal environmentThe government has proposed pulling out of the International Centre forSettlement of Investment Disputes. Supporters of President Morales in theConstituent Assembly have proposed allowing the leader to seek re-election foran unlimited number of consecutive terms.


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Colombia=: Political problems do not diminish strong performance.

GDP continues to surgeIt now looks as though economic growth will exceed 6.0% again this year afterthe best performance in 29 years in 2006. Fueled by high investment and

domestic consumption, the surge is taking place under tighter monetary policy.Inflation remains under control.

Uncertainty of FTA with United States clouds positive external pictureColombia has been so successful in attracting foreign investment that thegovernment deemed it necessary to impose capital controls on some foreigninvestments to curb appreciation of the peso. Foreign portfolio investors are nowrequired to deposit 40 percent of their investments in non-interest-bearingaccounts in the Central Bank for 6 months. These controls came as a supplementto the freezing of 40 percent of offshore loans and deposits repatriated by localcompanies. In June, S & P returned Colombias foreign credit rating to

investment grade. Concern on Capitol Hill about violence against trade unionistshas put approval of a U.S. free trade agreement with Colombia in doubt.

Difficult social environment continues to improveViolence and criminality declined again.

President exercises damage controlIn spite of a scandal over alleged administration ties to the rightwing paramilitaryforces, President Uribe continues to have favorable public opinion ratings becauseof the success of his administration in improving public security and overseeingthe economic recovery.

Policies tighten monetary policy and open energy sectorIn addition to capital controls, the Central Bank raised interest rates 300 basispoints since April 2006. Opening the energy sector to private capital took anotherstep forward through partial privatization of national oil company, Ecopetrol, bysale of up to 20% of its shares in an IPO (initially only to Colombians). The goalis to replicate the success of Petrobras in Brazil. A major reform of the Instituteof Social Services is behind schedule.

U.S. courts affect legal environmentWhen Chiquita Brands International pleaded guilty in the criminal prosecution

brought by the U.S. Department of Justice, it focused attention on the payoffs thatColombian and foreign companies make to the illegal armed groups. The civillawsuits filed in the U.S. have been brought under the Torture Victim ProtectionAct and the Alien Tort Statute, which allow foreigners to sue in U.S. courts onissues of internationally recognized human rights violations. The Drummondcase tested a new use of the 218-year-old law. Though the plaintiffs were notsuccessful, the lawsuit against Drummond could herald a new era for the AlienTort Statute to be used to sue multinational corporations suspected of human


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rights abuses in developing countries. Drummond marked the first time a U.S.company had gone to trial under the Alien Tort Statute. Other corporations maybe subject to similar suits and more of these cases will be brought unless the U.S.Supreme Court rules with greater clarity on what kinds of claims can be pursuedby foreigners in U.S. courts.

Ecuador: New president pledges to transform environment. Economic performance continues to be satisfactory

GDP growth averaged over a healthy 5.0% since 2003 but is forecast to decline in2007 in response to the uncertain business environment. Dollarization keepsinflation at bay.

More nationalist external positionBecause of high oil prices and favorable terms of trade, exports are up, and the

current account is in surplus. FDI has also increased, but investors may be morecautious as they wait for the Correa government to define its policies. Beforetaking office, the President-elect announced that his government wouldrenegotiate contracts with foreign oil companies and the countrys foreign debt.Once in office, his government moved ahead on renegotiating the oil contracts togive the state more control and a bigger share of the revenues. However, itcontinues to service the debt, which has lowered the risk of default. The neweconomy minister appointed in July stated that attracting investment was apriority. While Correa has rejected a full FTA with the United States, he did pushfor an extension of the ATPDEA to maintain one-way free trade.

Constituent Assembly takes center stage

President Correa promises to bring stability and accountability to Ecuadorsdiscredited political system. As he completes his first year in office, he has donebattle with Congress and the Courts, both held in very low esteem byEcuadorians. Now he is wagering the future of serious reform, and hisgovernment, on a Constituent Assembly, approved by 70% of the voters in anApril referendum. The challenges facing the president are formidable, but Correahas already demonstrated more staying power and more political acumen than hispredecessors.

Leftist policy orientation

Although nationalism and populism mark the new presidents policy rhetoric, hehas pledged to maintain dollarization of the economy despite his reservationsabout its efficacy. His government has instituted a program of monthly paymentsto poor families.

Legal environmentEcuador stated its intention to allow the 14 year-old U.S.-Ecuador bilateralinvestment treaty to expire. However, the treaty will continue in force unless one


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Central Bank raised the benchmark interest rate in July (to 4.75% from 4.50%) todampen inflationary pressures. The government launched an innovative public-private partnership (CRPAO) to generate badly needed infrastructure investment,especially in the southern highlands. The state oil contracting agency signedexploration contracts with private companies to become a net oil exporter.

Legal environment would be strengthened with FTAThe pending FTA provides a secure, predictable legal framework for U.S.investors in Peru, including the enforcement of labor and environmentalstandards, protection of intellectual property rights, and an effective process toresolve disputes.

Venezuela : Government launches 21st Century Socialism Economy heats up

Buoyed by the high oil prices that have financed record increases in governmentspending and a consumer spending spree, Venezuela continues to have the fastestgrowing economy in Latin America, with the non-oil sector growing faster thanthe oil sector. But it also has the highest inflation rate, more than double anyother economy in the region. Government price and currency controls haveproduced shortages and a black market (where bolivars traded at 4,800 to thedollar in August versus 2,150 at the official rate). With two of two of its biggestlistings(CANTV and EDC) removed by nationalization, the stock market, whichdid very well in 2006, was down 25% for the year in mid-September 2007. Incontrast, banks are doing well.

Redefining external positionOil prices and export volume give Venezuela the most favorable terms of trade inLatin America, which have produced strong external balances and allowed thecountry to reduce its debt burden. These developments have, in turn, led toimproved credit worthiness. Foreign investors, however, find Venezuela to be anincreasingly risky environment. The 2006 FDI flow was negative by $2.5 billion,and major oil firms announced their intentions to abandon Venezuela. WhilePresident Chvez continues to use petro-diplomacy to act as a rule-makerinstead of rule-taker on the international scene, his challenge to Brazil as thedominant nation in South America faces growing opposition. At the May 1 LaborDay celebration, the President announced that Venezuela was cutting its ties withthe World Bank and IMF in favor of developing regional financial institutions likeBanco Sur.

Growth and social spending reducing unemployment and povertyUnemployment fell below 10% for the first time in more than a decade.


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Chvez consolidating political controlFollowing his December 2006 re-election to a third six-year term, the Presidentmoved quickly to further concentrate power in his hands. Already controlling theother branches of government and the armed forces, he took steps to reduce theindependence of the media. He did not renew the license of Venezuelas oldest

private television station, and replaced it with a new state-funded channel. Inmid-August he called for constitutional reforms to end the autonomy of theCentral Bank and eliminate presidential term limits. The opposition continues tostruggle to present a unified, credible alternative.

From populism to socialismOn the eve of his January inauguration, Chvez announced he would nationalizethe leading telecommunications and power companies. Later in the year he seizedoperational control of four heavy oil projects in Orinoco basin, and threatened tonationalize other sectors of the economy. In the macroeconomic policy arena, inaddition to price controls and a fixed exchange rate, the government has also

resorted to bond sales to drain liquidity from the system.

Problematic legal environment for businessBased on the indicators in Tables 13 and 14, Venezuela has one of the most crimeridden, corrupt, bureaucratic, and least competitive legal cultures in LatinAmerica. Pending measures would order employers to grant their employees fourhours a week leave to attend ideological training in socialism and reduce the workweek to 36 hours. The government has also proposed a co-management systemwhereby employees would have the right to manage the company or share inprofits or both. A series of labor laws passed, generating additional costs forcompanies that continue to operate in the country.

BRAZIL AND THE SOUTHERN CONE

South American geopolitics has clouded the prospects of broadening and

deepening the integration of the continent. A year ago President Chvez announced that

Venezuela would be joining MERCOSUR, and Bolivia and Ecuador would be following.

These were seen as steps toward expanding MERCOSUR into a South American

counterpart to NAFTA. Now Venezuelas membership in MERCOSUR is caught up in a

spat between Chvez and the Brazilian Congress. Meanwhile Venezuela promotes its

ALBA trade bloc, which may emerge as its alternative to MERCOSUR if differences

cannot be reconciled. The fate of two other Chvez initiatives for South America Bank


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of the South and a South American natural gas pipeline are still on the agenda, but not

assured because of reservations on Brazils part. In the meantime, two-way Brazil-

Venezuela trade and investment are flourishing. Thus far the two neighbors have avoided

an irreparable rupture.

The unresolved dispute between Uruguay and Argentina over the construction of

two large cellulose mills on the Uruguayan side of a shared river continues unresolved.

Uruguay is covering its bets by entertaining the possibility of an FTA with the United

States, a move that would seriously undermine MERCOSUR. The MERCOSUR nations

created a regional parliament in December in a step toward replicating the experience of

the EU as a political bloc.

Brazil: Environment improves in face of corruption scandals.

Moving toward sustained growthBrazil has experienced 20 uninterrupted quarters of growth, and the rate is

increasing to a sustainable 4.0% plus. An equally noteworthy accomplishment isthe decline in inflation as a result of the inflation targeting policy. This hasallowed interest rates to come down, stimulating both consumption andinvestment. The BOVESPA stock index is at or near historic highs, and there hasbeen a steady stream of IPOs over the last two years.

Strong external performanceBrazil is taking advantage of the export boom to build up trade and currentaccount surpluses and increase foreign reserve holdings. This has allowed it toreduce its external debt and debt/export ratio. It has also strengthened the real 12.6% against the dollar thus far in 2007 which threatens to erode export

competitiveness. In recognition of these accomplishments, the ratings agenciesboosted the countrys credit rating to one notch below investment grade. NetFDI, which has weakened in recent years (in part because of Brazil-basedmultinationals expanding abroad), but the flow is positive and strong this year.On the diplomatic front, President Lula has pursued a foreign policy that balancesgood relations with Washington and Caracas and projects Brazil on to the worldscene as a leader of the emerging nations. He is also aggressively positioningBrazil to lead a global bio-fuels revolution.


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Poverty and inequality down but violence has escalatedAlong with theBolsa Familia that subsidizes low income families, growth isbeginning to reduce not only the poverty rate but also income inequality. On thenegative side, criminal violence linked to drug-trafficking is still a very seriousproblem, especially in Rio de Janeiro, leading the government to launch a major

anti-crime program in September. According to statistics, Brazil is one of thethree most violent countries in the world. Failure to control, much less reduce,crime increases investment risks and business costs.

The Teflon presidentLula began his second four-year term in January. In spite of the problemsbesieging the government this year high level corruption, ongoing violence, andthe aviation crisis his public opinion ratings remain favorable (over 50%). Oneexplanation is his popularity among low income Brazilians, whose standard ofliving is improving because of his income transfer programs. As with allBrazilian presidents, his biggest political challenge is to establish and maintain an

effective working majority in Congress, which involves constant horse-trading toget bills passed.

Solid macro-economic policy but reform lagsIn September the Central Bank lowered the key overnight SELIC lending rate to11.25% (down from 775 basis points since August 2005), but the reduction waslower than previous cuts because of growing concerns about rising food prices.The expectation that Lula would interpret his easy re-election as a mandate topursue serious structural reform and de-regulation does not seem likely to befulfilled. In protest over the governments support for embattled Senate presidentaccused of corruption, the opposition in Congress is currently holding up renewal

of the financial transactions tax (CPMF), a crucial source of revenue needed tofund a new infrastructure investment initiative among other programs. This isindicative of how difficult it will be for the popular president to push major itemsthrough the legislature.

Important developments in legal environmentIn August the Supreme Court for the first time in its history took steps that couldlead to the conviction of high level politicians (including a top former advisor tothe president) on charges of corruption for their involvement in the 2005Congressional vote buying (mensalo) scandal. Other developments in the legalenvironment include the adoption of a reform under which lower courts are bound

by Supreme Court decisions. This should help to reduce the number of cases inthe court system and provide greater predictability and transparency.Advancements have accompanied setbacks with the Brazilian decision to create acompulsory license for Mercks Efavirenz AIDS drug, allowing the governmentto break the drug companys patent and purchase a generic version from otherlaboratories. The move came just days after Brazil was recognized by the Officeof the U.S. Trade Representative for improving its enforcement of intellectualproperty rights, removing the country from the Priority Watch List to the Watch


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List in its annual Special 301 report. Progress on the intellectual propertyprotection front had been critical in U.S. Congresss extension of GeneralizedSystem of Preferences tariff benefits.

Argentina=: Inflation and energy problems to challenge next administration.

Growth continues strong but inflation a threatSince 2002 the GDP has expanded at an annual average rate of over 8%. Mostobservers, and most Argentines, are skeptical of official statistics and thegovernments claim that inflation is easing. These doubts have weakened thebond market. In general, the domestic capital market has yet to recover from the2002 crisis.

Mixed external performanceHigh commodity prices and favorable terms of trade sustain growth in exports and

the current account surplus. Foreign portfolio investment is strong, but FDI tooka big fall last year. Although the nominal external debt and debt ratio are veryhigh, they do not reflect settlement made with most bond holders.

Stronger social environmentUnemployment and poverty continue to decline

Cristina Kirchner set to succeed her husbandPresident Kirchners popularity declined this year in the face of embarrassingcorruption scandals, the winter energy crisis, and rising food prices.Although the opposition made some local electoral gains most importantly

winning the mayors office in Buenos Aires there is no serious challenge toCristina Fernndez de Kirchner winning the October election.

Interventionist policies distort economyEnergy shortages that occurred during an exceptionally cold winter underlined theconsequences of the governments failure to work out a settlement with energyproducers and public utility companies (whose tariffs have been frozen since2002) that would lure private capital back into the investment-starved energysector. Another problem in the policy arena is the extensive imposition of pricecontrols to hold down inflation. The government also intervenes in currencymarkets to minimize appreciation of the peso and short-term volatility.

Concerns over legal environmentConcerns over creditor and contract rights and unpredictable regulatory changesblemish the attractiveness of investing in Argentina. The country broke gascontracts with Chile, leading to gas shortages. It closed the local Shell refineryover an environmental dispute. State legislatures in Catamarca and Corrientesprovinces are contemplating the seizure of ranch land held by foreigners,reinforcing the message that investing in Argentina can be risky.


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Chile=: Mixed year for Latin Americas most attractive environment

Growth should top 6.0% but inflation a growing concernIndustrial production, domestic consumption and government spending alongwith exports are important components of the current expansion cycle.

Another strong external performanceChile continues to profit from record high copper prices, which give it extremelyfavorable terms of trade. Exports are growing at 20% annually; copper nowaccounts for over 60% of total exports, up from a little over 40% for mineralexports ten years ago. Imports are also growing rapidly, but Chile has a solidcurrent account surplus. The peso has appreciated but not enough to significantlyaffect the relative prices of Chiles exports. Net FDI in 2006 was second only toMexico in the region.

Protests in improving social environment

According to ECLAC, Chile has reduced the poverty rate to 18.8% today from38.6% in 1990 through a combination of sustained growth and targeted welfareprograms. Unemployment has also dropped. However, organized public protestsperiodically take place demanding more government attention to education,poverty and inequality.

President slides in pollsPresident Michelle Bachelet had a bumpy first year in office. A bungled effort toput a new, integrated public transportation system into place in Santiagogenerated much ill will. On the March anniversary of her inauguration, herpopularity was down to 47% from 65% when she took office. This led to major

changes in her cabinet, the second in a year. But her approval rating continues todrop down to 41% in September following more protests. The death ofmilitary president Augusto Pinochet in December removed a divisive elementfrom the political scene.

Interest rates upIn July the Central Bank began raising the benchmark interest rate (to 5.75% inSeptember) to rein in inflation fueled by rising food prices. Thus far higherinterest rates have not affected the growth rate. The government introduced twoimportant policy initiatives: reform of the privatized pension system and apackage of measures (Chile Invests) to boost economic growth

Measures strengthen legal environmentChile has the strongest legal environment in Latin America, and its program ofjudicial reform is considered a model. Violent street protests, largely by youths,have raised concerns. President Bachelet is expected to sign legislation removingthe requirement to prove intent in crimes committed by youth, and is proposinglegislation to hold parents legally responsible for the crimes of their children. The


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2004 International Arbitration Law has seen increased though still limited use asChile positions itself as a regional platform for international arbitration.

Paraguay: Country gearing up for election that could produce major change. Growth and inflation up

GDP is expected to increase by 4% again this year giving Paraguay the best twoyears in more than a decade. However, food price increases may produce double-digit inflation in 2007.

Strong export performanceHigh prices and a record soy harvest promise to sustain impressive export growthof recent years, although the country is still running a current account deficit. FDIshows modest increase, while the debt-to-export ratio continues to decline. TheIMF stand-by loan is in effect into 2008. Standard & Poors raised the long-term

sovereign credit rating in June from B- to B citing strong economic institutionsand more stable political outlook.

Opposition struggles to challenge ruling Colorado PartyElectoral politics are beginning to dominate the environment. Neither theColorado Party, which has controlled the presidency for six decades, nor theopposition coalition has yet to pick their nominees for the April 2008 vote fromamong competing pre-candidates.

Problematic legal environmentParaguay has traditionally had one of if not the most corrupt, least transparent

and most cumbersome environments for business in Latin America. There is noevidence that this is changing.

Uruguay : Continuing improvements make a more attractive environment. Four years of sustained growth

Rising food and energy costs are generating inflationary pressures in 2007.

Export growthhighlights external performanceBoth exports and imports showed significant increases in 2006. In June 2007

agricultural exports were up 30% over last year. The country steadily restructuredits debt profile, and was able to payoff its IMF loan. The government continuesto strengthen ties with the United States. In January it signed a Trade andInvestment Framework Agreement that could pave the way for a full FTA.President Bush included Uruguay in his five nation Latin American trip in March.


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Presidents popularity high at midtermMidway through his presidency, the government of Tabar Vsquez receivedfavorable ratings from two-thirds of respondents in a national poll, giving him thehighest approval rating in the region.

Reforms enacted

Uruguay has passed a series of tax and labor laws, leading to the implementationof personal income tax and the creation of a tax on corporate earnings.


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III. OUTLOOK

OUTLOOK FOR THE REGION

Well into 2007, the outlook for the Latin America was quite positive at least

through 2008. However, the emergence of volatility in international financial markets in

August means that the prospects for sustained growth under low inflation are less certain.

Below we examine the outlook over the next 15 months for each component of the

regional business environment before assessing the outlook for the 18 countries in the

next section. For each component and each country, we indicate whether it is likely to

get better (), get worse (), or stay the same (=) through 2008. We use ? to indicate

an uncertain outlook. We further identify key variables to monitor in the coming 12-15

months.

External Environment

Global The global environment is more uncertain now than a year ago. Key questionsare whether volatility that riled global financial markets will persist and spill over

into Latin America. For the time being, the consensus seems to be that the sub-prime-linked turmoil will be short-term and not deteriorate into a global financialcrisis. However, economists are beginning to reduce 2008 U.S. growth forecasts,some predicting a recession. Thus far the impact on Latin America has beenminimal, and the region is less vulnerable to external shocks thanks to currentaccount surpluses, trade diversification, large reserves, declining debt, flexibleexchange rates, and solid macroeconomic position. However, given thecontribution of strong commodity prices and reliance on global capital markets tothe current growth cycle, a financial meltdown would eventually take its toll.Keys: U.S. growth; global financial markets

Regional=Failure of the U.S. Congress to ratify the FTAs with Peru, Colombia and Panamawould not only be a setback for these countries and their relationship with theUnited States, but it would provoke yet another attempt to configure the Inter-American trade regime. Since the anti-immigrant sentiments in Congress areunlikely to diminish, the immigration issue will again be a point of contention.Keys: Congressional ratification of FTAs


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Domestic Environment

Economic and Financial Performance Forecasts for 2008 call for regional GDP growth to approach 5.0% again,although they are being revised downward in light of financial market volatility.

Stricter monetary policy to head off inflation may also bring down growth.Keys: Inflation

Social Environment=Declines in unemployment and poverty are very much linked to economicexpansion through job creation and social spending. A sharp economic downturnwould weaken the social environment.Key: Continued growth

Political Environment=In 2007-08, only five countries (the most important being Argentina) are

scheduled to hold elections. Thus far only Paraguay has a serious (mildly) anti-system candidate. The deliberations and outcome of the efforts to rewriteBolivias and Ecuadors constitutions will indicate if further erosion of theinstitutions of representative democracy are occurring.Keys: Elections in Dominican Republic, Guatemala, Argentina and Paraguay;

constituent assemblies in Bolivia and Ecuador

Policy Environment =Venezuela has decided to abandon the policy prescriptions of the WashingtonConsensus. Its government embarked on a deliberate path of nationalizingimportant sectors of the economy. In implementing price controls and a fixed

exchange rate, it is abandoning the core macroeconomic components of the NewEconomic Model. While unlikely to trigger a region wide developmentalparadigm shift that would be less business friendly, the governments of Bolivia,Ecuador and Nicaragua seem inclined to replicate facets of the Venezuelan model.Should the external environment become less favorable for Latin America, othergovernments might come under pressure to join the populist policy camp.Key: Interest rates

Legal EnvironmentThe outlook for the legal environment is mixed. Countries that have entered intofree trade agreements with the U.S. are implementing reforms that should

strengthen their justice systems and protections for investors. Crime will continueto be a problem region-wide. Chile, Costa Rica and Uruguay display continuedstrength and stability in their legal and business environment indicators and nochange is expected. Venezuela, displaying an abysmal rule of law percentile rankof 9.2, will continue to be a volatile environment with Bolivia and Ecuadorfollowing suit. Peru will be particularly interesting to watch in the coming year.The country is pursuing aggressive judicial reforms and boasts a strong economybut social unrest is not abating. The Alien Tort Statute is likely to be increasingly


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used to sue multinational corporations suspected of human rights abuses indeveloping countries unless or until the U.S. Supreme Court rules with greaterclarity on what kinds of claims can be pursued by foreigners in U.S. courts.Keys: Congressional action on FTAs; outcome of suits against Chiquita andCoca Cola.

COUNTRY OUTLOOKS

This section divides the 18 countries into three categories according to the overall

character of their business environments attractive, problematic or mixed in 2007, and

then assesses the outlook for each through 2008. Based on sustained improvements in

recent years, we upgraded three countries (Panama, Peru and Uruguay) from mixed to

attractive, increasing the number in the most desirable category from four to seven. In

2005, the business environments in only three countries (Mexico, Costa Rica and Chile)

were assessed as attractive, which reflects the overall improvement of Latin America in

recent years. Brazil, and possibly, Colombia are candidates for upgrading next year,

although neither is expected to improve significantly in 2008. At the other end of the

spectrum, four countries (Nicaragua, Venezuela, Bolivia and Ecuador) continue to have

problematic environments. While the government of Venezuela is not likely to make the

business environment in that country attractive to private investors, important decisions

to be taken in Bolivia and Ecuador could alter the mix of opportunities and risks for

investors in a favorable or unfavorable direction.

Attractive Environments

A quick review of the 14 tables in the Appendix confirms why Chile has the most

attractive environment for business in Latin America. It has the most diversified trade

linkages, extremely favorable terms of trade, strong and sustained capital flows, dynamic

growth with low inflation, strong export growth, manageable debt, declining poverty,


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stable politics and consistent, market-friendly policies. The rule of law is strong and

getting stronger. The other six countries do not match Chile across the board, but

nonetheless, feature a combination of interesting opportunities and relatively low risks.

Mexico is Latin Americas second largest economy, and is closely integrated to the

United States through NAFTA. The Dominican Republic, now linked to the United

States through DR-CAFTA, has bounced back from a sharp downturn to resume a high

rate of growth. Costa Ricas positive ranking is due to its educated population, stable

politics and strong legal culture, plus the resumption of high growth. Uruguay presents a

similar profile. The newcomers, Panama and Peru, have significantly improved their

performance and policy management.

Mexico Although President Caldern faces serious challenges opening the energy sectorto private investment, reforming labor markets, breaking up near monopolycontrol of private groups and effectively combating drug trafficking he hasdemonstrated the political acumen necessary to mount effective responses.Keys: Continued progress on economic reform; U.S. growth

Dominican Republic=Politics will heat up as the May election draws near. Barring the unexpected,Leonel Fernandez will be elected to a third term. DR-CAFTA presents both anopportunity and challenge. While it guarantees access to U.S. and CentralAmerican markets, it also opens an economy hindered by infrastructure, educationand competitiveness deficiencies to cheaper imports. One key will be the abilityof the duty-free industries to take advantage of liberalized access to the UnitedStates gained under the agreement.Keys: May election; impact of DR-CAFTA

Costa Rica?

Given Costa Ricas strong performance over the past few years, failure to ratifyDR-CAFTA may not be as deleterious as might be expected. However, a no votewould have negative consequences, not least by raising doubts about the ability ofPresident Arias to effectively govern through the rest of his term. There wouldalso be uncertainty about the terms of U.S.-Costa Rican trade (40% of all itstrade) going forward as well as the future path of Central American integrationwithout full Costa Rican participation.Keys: Outcome of DR-CAFTA referendum


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Panama Following revisions in the labor and environmental components to accommodateDemocrats, it now appears likely that the U.S. Congress will ratify the FTA. Thecanal expansion promises sustained growth and rising employment. The main

challenge will be to maintain macroeconomic equilibrium and avoid corruption.Keys: U.S. ratification of FTA; canal expansion

Peru=Alan Garcia has proven to be a stronger, more effective leader than all but hisclosest supporters might have expected, given Perus weak institutions and thedisaster of his first term. He must now rise to the task of managing recovery fromthe August earthquake while coping with the passions certainly to be unleashedby the trial of Alberto Fujimori. Peru has accumulated strong reserves so it iswell insulated from external shocks triggered by falling metal prices.Keys; U.S. ratification of FTA; Fujimori trial

Chile=A slowdown in the world economy that led to lower commodity prices could havehad an impact on Chile, given the importance of copper exports. Chile alsoimports much of its energy from sources that are not always dependable. On theother hand, with a large rainy-day reserve fund, diversified trading partners and astrong state, Chile is better prepared to cope with such challenges than othercountries in the region.Keys: Energy supplies; inflationary pressures

Uruguay Socialist president Tabar Vsquez has quietly maintained the policies of hispredecessor to transform Uruguay into the most open, dynamic and well managedsmall economy in Latin America.Keys: MERCOSUR relations

Problematic Environments

Even though three of the four countries in the problematic category are

experiencing high growth thanks to high energy prices and very favorable terms of trade,

they offer an unfavorable risk-reward calculus. Venezuela has explicitly opted for a

development strategy that privileges the state over the market, private investment, and

property rights. Nicaragua, Bolivia and Ecuador are in the process of deciding how far


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they will go down the populist-socialist path. Consequently, the level of uncertainty is

high in all three.

Nicaragua?

President Daniel Ortega has zigzagged between a new business-friendly versionof himself and the old Sandinista radical. This raises doubts about the advisabilityof investing in Nicaragua. He has also promised to push for constitutionalreforms that would allow immediate re-election certain to provoke confrontationwith the opposition and periodically seems intent on picking a fight with theUnited States.Keys: Foreign investment flows; relations with Washington

Venezuela The government is expected to devalue the bolivar within the next year. It alsoannounced that it will hold down spending in the next fiscal year. If these

measures fail to bolster the bolivar and reign in inflation, the businessenvironment will become even more unsettled as would additionalnationalizations. Because it includes a provision that would shorten the work day,the December constitutional referendum is likely to pass. This would eliminatepresidential term limits, curb the autonomy for the Central Bank and strengthenpower of government to expropriate private property. Even if prices stay high,Venezuelan oil revenues may decline since production has been declining.Keys: Oil prices; inflation; December referendum

Bolivia?Foreign investors have not given up on Bolivia. Its energy and mineral reserves

are too valuable, plus until now the government has eschewed the more radicalChvez path in favor of a more measured nationalization program that carves outa role for the private sector. All eyes are now on the Constituent Assembly. Willit resume its deliberations? If it does, will it be able to arrive at compromises (onregional autonomy, land reform, the states role in the economy and presidentialre-election) acceptable to the contending factions? If not, Morales may face thepolitical chaos that forced his predecessors from office.Key: Deliberations of Constituent Assembly

Ecuador?Rafael Correa has succeeded in imposing a degree political stability and policy

direction, but there remains a high level of uncertainty in the environment. TheConstituent Assembly will define the environment. Since Correa won a majorityin the assembly in the September vote, he has a great deal of leeway in imposinghis vision of a new Ecuador. Correa has disassociated himself from the moreextreme steps take

2007 latin american-business environment report

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